The present invention relates generally to methods and apparatuses for trading securities or other instruments, and more particularly to a method and apparatus for trading securities or other instruments on behalf of investors, in which the trades are aggregated and netted against each other prior to executing the remaining trades.
The present invention is related to U.S. patent application Ser. No. 09/038,158 and to U.S. patent application Ser. No. 09/139,020, which is a continuation-in-part of U.S. patent application Ser. No. 09/038,158. Both applications disclose a portfolio manager for creating and managing portfolios of securities, in which, among other things, trades are aggregated and netted prior to executing certain types of securities trades. Both U.S. patent application Ser. Nos. 09/038,158 and 09/139,020 are hereby incorporated by reference, as if repeated herein in their entirety, including the drawings.
Traditional full-service and online brokerages accept orders to purchase a particular number of shares of a security. The brokerages then execute those orders through a market maker in that security. These orders may take one of a variety of forms. The basic forms include: (a) market orders, in which the customer orders the brokerage to buy or sell a specified number of shares at the best price currently available in the market; and (b) limit orders, in which the customer orders the brokerage to buy or sell a specified number of shares at or better than a specified price. The orders are then relayed to market makers for execution in essentially the same form that they are presented to the brokerages by the customers. That is, the brokerages frequently do little more than pass the order on to the market maker for execution.
There are several limitations to this traditional method of executing orders to trade securities. First, they are relatively inefficient from a transaction cost perspective. There are economies of scale to be gained by aggregating and/or netting the orders and presenting the market maker with one large order per stock, rather than hundreds or even thousands of small orders per stock.
Second, this method does not always secure the best execution for customers. For example, assume the bid-ask spread on a stock X is $1. If customer one, C1, wants to buy that stock from a brokerage using the traditional method, C1 will pay Pa (the ask price). If the brokerage has another customer, C2, who wants to sell the same stock at the same time, C2 will pay Pb (the bid price)=Pa−$1. If the brokerage were to aggregate and net the orders, however, it could execute the trade at a superior price from the perspective of both C1 and C2 by selling C2's stock to C1 at the mid-point price, Pm=(Pa+Pb)/2. This yields the buying customer a lower price and the selling customer a higher price than either would get under the traditional method.
Third, the traditional method requires investors to trade in share amounts, rather than dollar amounts. Normally, an investor places a market order by specifying a number of shares that the investor wishes to buy or sell and entrusting the brokerage to obtain the best execution within a short time-frame. The investor using a market order can approximate the dollar amount involved in the transaction only by multiplying the number of shares specified by the price at which the investor believes the trade will be executed. Typically, however, the investor has only a rough idea of what the execution price will be. The investor has a somewhat better idea of what the maximum or minimum dollar amount of a purchase or sale will be if the investor places a limited order. Even under a limited order, however, the investor will not know the dollar amount of the trade until the trade is executed.
Some of these problems can be solved through a method and apparatus that allows investors to express orders in either share or value-base terms and then aggregates and nets those orders. U.S. patent application Ser. No. 09/516,787 filed concurrently herewith by the same inventor discloses a method and apparatus for enabling investors to express and submit trading orders in the form of share-base and dollar-based (or value-base) orders, which application is hereby incorporated by reference as if repeated herein in its entirety, including the drawings.
Receiving trading orders at the brokerage in dollar-based or share-based orders presents new challenges, however. If some customers express orders in share amounts and some customers express orders in dollar amounts, there is currently no way to execute the order that provides customers with the same price regardless whether they express their order in terms of shares or dollars without the brokerage assuming a sizable amount of risk.
Assume, for example, that the brokerage receives orders aggregating and netting to the following:                buy 1000 shares of X at Pmkt (market price) and        $100 dollars worth of shares in X at Pmkt.        
If the price of X were $10 per share, the brokerage would send an order to buy 1100 shares. If the price of X were to move from $10 to $11 between when the brokerage sent the order and when the market maker executed the order, this order would result in the brokerage owning too much stock. The brokerage would use 1000 shares to cover the share-based orders. The brokerage would then use the next 90.91 shares to cover the dollar-based orders. The brokerage would be left owning 9.091 shares for which it had no customer orders. This would expose the brokerage to risk that it might not wish to accept. Multiplied by thousands of orders and, potentially, thousands of shares, this risk adds up and could put millions of dollars of the brokerage's assets at risk.
Accordingly, there is a need in the art for a method and apparatus for removing inefficiencies in the trading of securities or other tradable instruments representing underlying assets and liabilities, while adding more certainty to the trader as to the amount of the transaction prior to execution or even submission to the brokerage.